IMF Executive Board Concludes 2005 Article IV Consultation with Nicaragua

This paper discusses Nicaragua’s 2005 Article IV Consultation and Seventh, Eighth, and Ninth Reviews Under the Three Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF). The economy continued to perform well, notwithstanding pressure from higher oil prices. Strong performance under the program in 2003–04 allowed Nicaragua to reach the Heavily Indebted Poor Countries completion point in January 2004. Since then, growth has moderated toward 4.1 percent y/y in 2005. Key medium-term challenges include addressing vulnerabilities arising from weak balance sheets, reflected in high levels of debt and dollarization.


This paper discusses Nicaragua’s 2005 Article IV Consultation and Seventh, Eighth, and Ninth Reviews Under the Three Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF). The economy continued to perform well, notwithstanding pressure from higher oil prices. Strong performance under the program in 2003–04 allowed Nicaragua to reach the Heavily Indebted Poor Countries completion point in January 2004. Since then, growth has moderated toward 4.1 percent y/y in 2005. Key medium-term challenges include addressing vulnerabilities arising from weak balance sheets, reflected in high levels of debt and dollarization.

On January 18, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Nicaragua.1


Nicaragua has made many important advances in the last few years. The economy has grown and poverty has fallen in the context of a stable macroeconomic environment that has supported real incomes of the poor and created more jobs. Several key reforms have advanced in the areas of improving revenues, and strengthening governance and the financial sector framework.

Following a decade of economic decline, the return to democracy and adoption of economic reforms in the early 1990s generated a strong recovery. Nonetheless, this period also saw the emergence of new vulnerabilities, including high fiscal deficits and a widening current account deficit financed in large part by official transfers. Moreover public sector debt levels remained elevated at close to 200 percent of GDP. In 2000-01, the economy deteriorated sharply following a severe banking crisis, a weakening of fiscal and monetary policy and a deterioration in the external environment.

The government that took office in 2002 moved quickly to address the large imbalances, tightening the fiscal and monetary policy stance. The authorities’ economic program was supported by a PRGF arrangement approved in December 2002. Real GDP growth increased from 0.8 percent in 2002 to 5.1 percent in 2004 and inflation remained stable, averaging 6.6 percent in this period. Nicaragua reached the HIPC completion point in January 2004 and the NPV of the country’s external debt should fall from 120 percent of GDP at end-2004 to 70 percent of GDP upon full delivery of expected HIPC relief.

Subsequently, the economy has been adversely affected by the increase in international oil prices, which has slowed growth and contributed to higher inflation. Real GDP growth is expected to have moderated to 4 percent y/y in 2005 while inflation ended the year at 9.6 percent y/y and the foreign currency reserve coverage ratio decreased to about 2.6 months of imports. The program went off-track at the end of 2004 reflecting the impact of heightened political tensions on policy implementation. Since then the authorities have sought to reforge the domestic political consensus for economic reforms, strengthen the macro-policy framework and advance key structural reforms to bring the program back on track. They have taken measures to bolster fiscal performance such that the consolidated public sector (CPS) deficit after grants is expected to fall to 2.2 percent of GDP in 2005. Meanwhile, monetary policy has continued to be conducted in the context of the crawling peg exchange rate regime with the currency depreciating by 5 percent per annum.

In order to strengthen the macro-policy framework further, the 2006 budget targets an unchanged CPS deficit in 2006 at 2.2 percent of GDP which should support stability in the run-up to this year’s elections. To preserve competitiveness and the room for poverty spending, the budget contains the growth of the public sector wage bill broadly in line with expected inflation. Since adoption of Nicaragua’s first PRSP in 2001, poverty reducing spending has been increased from about 10 percent of GDP in 2002 to 13½ percent of GDP projected for 2005.

The authorities have made renewed advances on the structural reform agenda in recent months. The assembly has approved three key financial sector laws, which together represent significant reforms in line with FSAP recommendations. They have also approved the financial administration law which strengthens budgetary procedures and the fiscal framework. Other measures have sought to off set the fiscal impact of the decentralization process and contain losses in the electricity sector.

Executive Board Assessment

Executive Directors commended the Nicaraguan authorities for maintaining a broadly stable macroeconomic framework, with continued growth, rising reserves, and lower fiscal deficits. They welcomed the efforts of the authorities to strengthen the domestic consensus in favor of the reform agenda supported by the PRGF arrangement. The recent political accord has allowed for passage of key measures under Nicaragua’s reform program that hold the promise of strengthening medium-term sustainability, and supporting the economic growth that will be needed to reduce poverty levels—which remain among the highest in the region—and to achieve the Millennium Development Goals (MDGs). In this context, Directors welcomed the authorities’ commitment to use resources set free through the debt reduction provided by the Fund to Nicaragua under the Multilateral Debt Relief Initiative (MDRI) for poverty-reducing spending, and recommended that such spending be monitored closely. They encouraged the authorities to continue negotiations with creditors, including non-Paris Club creditors.

Directors cautioned that, despite the positive orientation of recent policies, significant vulnerabilities remain, including from the level of public debt—which is still high even after MDRI debt reduction—a large current account deficit, and widespread financial system dollarization. In that light, prudent macroeconomic policy implementation will be important, focusing on key structural reforms in the fiscal, energy, and financial sectors aimed at fostering growth and promoting fiscal consolidation—while increasing the scope for poverty-reducing spending. Directors welcomed Nicaragua’s approval of the U.S.-Central America-Dominican Republic Free Trade Agreement (CAFTA-DR), but noted the need to improve the investment climate, governance, and the legal and regulatory framework further in order to leverage fully the Agreement’s potential.

Directors welcomed the authorities’ progress in implementing the poverty reduction strategy, and the revised and improved second-generation PRSP (PRSP-II) that has been incorporated in the 2005-2009 National Development Plan. They broadly welcomed the formulation of the PRSP-II through a participatory process, and its emphasis on increasing economic activity and employment in order to promote poverty reduction. Directors noted that poverty-reducing spending has increased, resulting in an improvement in indicators in the education and water sectors. They looked forward to the release of more recent data regarding poverty trends.

Directors commended the authorities for the disciplined fiscal policy stance of the 2006 budget, which will support stability in the run-up to the elections. They stressed the importance of adhering to the budget framework in the election year, and of identifying measures that could be taken in the event of unforeseen shocks.

Directors encouraged the authorities, in light of the rapid growth of public sector wages over the last few years, to maintain tight control over the public sector wage bill. They therefore welcomed that the budget broadly contains the growth of the wage bill in 2006 to the expected inflation rate. They urged the authorities to resist any pressures to increase public sector wages beyond program levels. At the same time, a few Directors recommended that the authorities re-examine the structure of the public sector wage bill to ensure that priority pro-poor services were not compromised.

Directors supported the steps taken by the authorities to contain losses in the electricity sector, which had begun to threaten the overall fiscal position, while protecting low-income electricity consumers through targeted subsidies. Looking ahead, Directors noted that further rate increases would likely be needed to fully eliminate losses. They emphasized the need to strengthen the regulatory framework to attract much-needed investment in energy assets. In this regard, the recently approved Energy Stability Law should be amended to eliminate distortional interventions in the energy market.

Directors welcomed the central bank’s intention to tighten liquidity conditions to curb rapid credit growth and safeguard reserves. They noted that this would also help contain the recent pick-up of inflation, which seemed to reflect in part second-round effects of the oil shock and demand pressures from rapid growth in credit and public wages. Directors agreed that the current crawling peg exchange rate system is appropriate, and that keeping the rate of crawl of the depreciation of the córdoba unchanged in 2006 would appropriately balance stability and competitiveness. At the same time, Directors recommended that, after financial sector strengthening and full credibility of the macroeconomic policy framework have been secured, the authorities should consider moving over the medium term toward a more flexible exchange rate arrangement.

Directors stressed the importance of taking early steps to strengthen the elements of the tax code governing the powers and operations of the tax administration. In this regard, they were concerned that the tax code approved last year would weaken the authority of the tax administration and could undermine revenue collection. Accordingly, Directors urged the authorities to amend the law soon in line with international best practice, as envisaged under the program.

Directors welcomed the measures taken to safeguard the fiscal framework, including the passage of the Financial Administration Law. They stressed that a significant fiscal reform agenda remains to be articulated and implemented. In particular, Directors highlighted the need to develop a plan to set the public pension system on a sound actuarial foundation and prepare a strategy to introduce a disciplined fiscal responsibility framework. The decentralization framework needs to be reformed to link the devolution of revenue transfers to municipalities with spending responsibilities and accountability in a transparent manner. Directors also advised the authorities to consider reducing earmarking of budgetary resources over time to support fiscal flexibility. They looked forward to action in these critical areas soon after the elections.

Directors commended the authorities for the approval of several key laws on banking and supervision, in line with many core FSAP recommendations, which they considered have strengthened the financial sector framework. However, further work is needed to ensure smooth implementation of these laws. Directors welcomed the authorities’ plans to incorporate additional FSAP recommendations into their reform agenda, in particular, to strengthen central bank independence and reinforce the protection of bank supervisors, especially against criminal prosecution related to their good-faith official actions. The progress made in strengthening the legal and institutional framework to counter money laundering and the financing of terrorism was noted, but the authorities were encouraged to expand the Financial Analysis Commission and create an independent Financial Intelligence Unit.

Public Information Notices (PINs) form part of the IMF’s efforts to promote transparency of the IMF’s views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The Staff Report for the 2005 Article IV Consultation with Nicaragua is also available.

Nicaragua: Selected Economic Indicators

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Sources: Central Bank of Nicaragua; Ministry of Finance; and IMF staff estimates/projections.

Actual outcome.

After HIPC relief, assuming that negotiations with non-Paris Club and commercial creditors are completed by end-2005. Includes accrued interests on private debt in arrears.


Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities.